Heavy mortgages have already left tens of thousands of borrowers in financial difficulty! Rising mortgage rates could hit the entire housing market

The latest monthly credit report from Centrix shows that the number of borrowers in financial difficulty reached 11,900 in month 4, up 10% compared with the preceding three months. The number is expected to keep rising over the coming months. In other words, current low interest rates have enticed many people to enter the market——and buy a home. An upward shift in interest rates will leave those already in financial difficulty even more vulnerable, exposing them to substantial financial risk.

Most homebuyers currently in the market, including investors, have expressed concern that a near-term rise in mortgage rates will expose them to greater financial risk.

“A mortgage is a long-term financial commitment, so it is important that new borrowers do not overcommit.” Here, “overcommit” means that people must stay within their means. 

Reserve Bank of New Zealand Governor Adrian Orr told the AM Show last Thursday that New Zealand house price growth was expected to “stall” for a time, with a risk of prices “moving sideways”. He reminded homeowners that “it is time to consider what the average interest rate will be over a period of time”, rather than focusing solely on current rates. 

ASB said this week that mortgage rates could be 1–1.5 percentage points higher than current levels by 2025. 

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Let us work through an example:

For a mortgage of NZ$500,000 over 30 years, with a one-year fixed rate of 2.25%, monthly repayments would be approximately NZ$1911. A one-percentage-point increase, to 3.25%, would raise monthly repayments to NZ$2176. In other words, if rates rose by 1–1.5 percentage points, borrowers would pay at least an extra NZ$265 a month. This calculation is based on a loan of just NZ$500,000. Given Auckland’s current high house prices, many borrowers may have larger mortgages and face an even greater impact.

Wayne Henry, managing director of Wayne Henry Mortgages, said: “Mortgage rates that remain at historic lows may create a false sense of security. Over the next 3 to 5 years, the cost of rising interest rates will hit people across the country. This is something both borrowers and banks must consider.”

In our view, borrowers currently need to focus on the effects of rising interest rates and slowing house prices.

The “lure” of low interest rates has already left tens of thousands of mortgage borrowers in financial difficulty. Rising rates will undoubtedly be the final straw. How, then, can buyers keep their financial risk relatively low when purchasing a home?

 

01  Get finance pre-approval first:

Pre-approval is a crucial first step in borrowing. It provides an important assessment of a borrower’s current financial position and indicates how much they can borrow. Mortgage lenders must analyse factors such as the borrower’s savings and salary before advising what price range they can afford.

However, Henry said: “Borrowers are responsible for ensuring they can afford repayments and understand the costs of owning a home, while banks should take each borrower’s monthly expenses into account.”

“If you are not prepared for all the costs associated with buying a property, such as insurance, rates, maintenance, urgent renovations, internet, electricity and any additional household items, I suggest you do not rush into borrowing to buy a home. That would expose you to greater financial risk,” Henry said.

Sarah Curtis, who heads a well-known mortgage company, said: “Having a pre-approved amount provides greater reassurance about a mortgage. Banks set limits based on what borrowers can afford, but borrowers should speak to their bank or mortgage broker before committing to a property purchase. Once a contract is signed, they must make the repayments they have committed to.”

 

02  Set a maximum purchase price:

Curtis said that buyers face competition from others, particularly at property auctions. Intense competition can lead borrowers to make hasty decisions about their housing budget. To avoid committing beyond their means, buyers should know their limit clearly before bidding or negotiate in writing.

Money Empire senior financial adviser Lisa Barton also advised borrowers to be very clear about what they can afford, to avoid the financial pressure of buying beyond their budget.

 

03  Choose a suitable mortgage rate structure for your needs:

Choosing an appropriate mortgage rate structure can help borrowers reduce interest costs and ultimately save money.

Option 1:

A floating rate gives borrowers the flexibility to make extra repayments and pay off their loan faster. The rate moves up and down and is usually higher than a fixed rate.

Option 2:

A fixed rate provides certainty about repayments over a specified term, from six months to seven years, but early repayments usually incur a fee.

Option 3:

Flexible repayments — a revolving credit facility 

Loan Market mortgage adviser Megin Wilton said borrowers who can control their spending and use income such as commissions or bonuses to make extra repayments could consider the most flexible home loan option currently available: a revolving credit facility. 

Put simply, a revolving credit facility is like a credit card with a large limit. “You pay interest only on the outstanding balance, with greater freedom to make extra repayments while retaining your savings.”

A revolving credit facility has no set limit, but borrowers can set one between NZ$10,000 and NZ$50,000 to suit their circumstances. It usually carries a floating rate, higher than a fixed rate, and can save interest costs if used properly.

A mortgage is a long-term financial commitment. Everyone should choose the approach that best suits their circumstances to avoid a debt crisis. Research shows that prolonged, severe financial stress can have a major impact on family, daily life and health. In the current hot property market, staying within your means is the wisest choice.